Dollars and Sense: Oil prices are playing havoc with the markets

Stock market volatility. Volatility was back last week, and a lot of the news seemed to revolve around oil prices. We saw a couple of days last week with 200-point moves on the Dow. On Friday, the Dow dropped more than 300 points. Oil prices got a lot of the blame for the volatility. West Texas Intermediate has now dropped to $60 per barrel, its lowest price in five years.

Complicated relationship. But the correlation between oil prices and the stock markets is complicated. Some days the markets rise when oil prices drop, and some days the markets sink too. The relationship is more complicated than a simple cause and effect. The best place to begin is to observe that oil prices have risen since 2009 because the global economy improved and the demand for energy rose. So in that environment, a rising oil price was a good sign. Oil price was a proxy for business confidence and for global growth projections.

Roller coaster price for oil. But between 2009 and just a few months ago, oil went from less than $60 to more than $100 per barrel. As the price rose, it became economically viable for new producers to enter the market. Hydraulic fracturing, or fracking, made previously marginal oil and gas fields profitable, especially when the price went above $70 to $80 per barrel. So for the past few years we’ve seen the United States become very nearly energy self-sufficient because of new production. And prices stabilized at around $100 per barrel.

Enter OPEC. All that sounds good, and it mostly is. But this narrative has several gaps that, if you understand them, help show this upbeat assessment is not sustainable. Perhaps most importantly, the Middle Eastern OPEC members (Organization of Petroleum Exporting Countries) can produce oil at a much lower cost than U.S. companies, and they have seen some of their markets dry up as America has become a net exporter of oil. So OPEC lowered prices. Secondly, global growth has slowed, especially in China and Europe. So we’re now seeing prices drop. The $60 West Texas Intermediate is the inflection point for a lot of producers, the point at which production starts to become unprofitable. That’s what’s been roiling the markets these past couple of weeks.

Effect on GDP. Things get even more complicated when you take into account that lower oil prices mean lower gas prices, which mean more money in the pockets of consumers. In fact, some economists say that for every $10 drop in oil prices, we get a 0.2 to 0.5 percent increase in gross domestic product. Lower gas prices also help keep inflation at the consumer level in check. So if you work in the energy business, you could be entering a difficult season, but lower oil prices are mostly good news for the rest of us—at least in the short term.

Speaking of retail. As an example of the point I just made about consumer spending, retail sales jumped in November—0.7 percent from October’s number and 4.9 percent from a year ago. Both numbers significantly beat analysts’ expectations. Some had speculated higher November sales were simply the result of people doing their holiday shopping early. That phenomenon likely did hurt Black Friday sales, but probably not sales generally. The trend since September has been upward, and early indications are that December sales will remain strong even with early shopping in November.

The week ahead. It will not be a heavy week for economic reports, but we do get the monthly consumer price index report on Wednesday. And on Tuesday we’ll get the monthly report on housing starts and building permits. These reports will tell us whether the global concerns we’ve discussed are having an impact on Main Street USA. Analysts, by the way, expect positive numbers for all three reports.